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The government’s demonetisation exercise has had an impact on liquidity of Micro, Small & Medium Enterprises (MSME) in the country, according to a recent nationwide survey by the global analytical company CRISIL.

“Every third MSME is also facing delays in receivables from clients, which has curbed their ability to repay creditors, and pay salaries, on time,” said the survey that covered more than 1,100 MSMEs between November 24 and December 24. “The steel sector was the most impacted on this score, with nearly two-thirds of respondents admitting to problems, followed by textiles, logistics and construction sectors,” CRISIL said.

There are about 51 million enterprises in the MSME segment in India. They have generated employment for about 117.1 million persons and accounted for 37.5 per cent of the country’s GDP, according to the MSME ministry. As per the Federation of Indian MSMEs (or FISME), a majority of MSMEs conduct their transactions, including sales, purchase and payments of wages, in cash and therefore their businesses have come to a “grinding halt” following the government’s surprise announcement on November 8 to withdraw notes in the denomination of 500 and 1,000 that accounted for 86 per cent of the currency in circulation in value terms in the country.

Informal funding unavailable

What is hurting MSMEs the most following demonetisation is the delay in receivables from big clients, that is the Centre/State governments & their agencies, public sector units and large private corporate entities. MSMEs are no strangers to such payment delays. According to a report published in September 2015 by Knowledge and News Network – a venture between FISME and GIZ (the German Agency for International Cooperation) – a study of the balance sheets of the top 2,700 non-MSME companies in India showed that “the biggest of Indian companies are holding on 10,000 crore due to micro & small enterprises against supplies made by them.”

FISME sources said, however, unlike earlier, MSMEs are now unable to fall back on informal sources of affordable finance particularly for their working capital as such funds have dried up due to the cash crunch after the demonetisation drive. Though the MSME Development Act addressed the issue of delayed payments to MSMEs by specifying that the buyer of goods or service will have to make payment to the (MSME) supplier within 45 days from the day of acceptance (or deemed acceptance), FISME sources said in reality this period stretches to an average of about 65 days and in some cases even up to 120-150 days. About 90 per cent of MSMEs rely on informal sources for credit, as per government estimates.

‘Demand for credit’

S.S. Mundra, Deputy Governor, Reserve Bank of India (RBI), had, in August 2016, referred to “a huge unmet demand for credit for MSMEs” saying, “As per provisional data for the period ended March 2016, total outstanding loan of the banking system to MSME sector stood at around 11.1 trillion in 20.6 million loan accounts. Contrast this to the estimated need of 26 trillion (or $520 billion of debt demand in the MSME sector) and the number of MSMEs at 51 million.” Mr. Mundra said there is a total finance requirement of 32.5 trillion ($650 billion) in the MSME sector - an amount comprising 26 trillion ($520 billion) of debt demand and 6.5 trillion ($130 billion) of equity demand. ‘Raghuram Rajan, in July 2016 while he was the RBI Governor, had said, MSMEs get squeezed all the time by their large buyers, who pay after long delays. All would be better off if the MSME could sell its claim on the large buyer in the market. The MSME would get its money quickly, while the market would get a claim on the better-rated large buyer instead of holding a claim on the MSME.”

Mr. Rajan said all this would happen when the three Trade Receivables Discounting Systems (TReDS), which the RBI has licensed, start later this (2016-17) financial year. “The key is to reduce transaction costs by automating almost every aspect of the transaction so that even the smallest MSMEs can benefit,” he had said.

In his speech announcing the Budget 2015-16, finance minister Arun Jaitley pointed out that a significant part of the working capital requirement of an MSME arises due to long receivables realisation cycles. “We are in the process of establishing an electronic TReDS financing of trade receivables of MSMEs, from corporate and other buyers (including government departments and state-owned enterprises), through multiple financiers. This should improve the liquidity in the MSME sector significantly,” Mr. Jaitley had said. According to Mr. Mundra, the objective of TReDS is to create Electronic Bill Factoring Exchanges that could electronically accept and settle bills so that MSMEs could encash their receivables without delay. When he took over as the RBI governor in September 2013, Mr. Rajan had said the RBI “intends to facilitate Electronic Bill Factoring Exchanges, whereby MSME bills against large companies can be accepted electronically and auctioned so that MSMEs are paid promptly.” He said this was a proposal in the report of his Committee on Financial Sector reforms in 2008, and that he intended to see it carried out.

In March 2014, the RBI had brought out a ‘concept paper’ on ‘Trade Receivables and Credit Exchange for Financing MSMEs’ and had sought feedback from stakeholders. In this regard, the concept paper detailed the well-recognised model of the Mexican Development Bank that runs a programme based on reverse factoring to facilitate the liquidity and financing requirements for MSMEs in Mexico. As per the paper, India has a similar initiative - the SIDBI-NSE Trade Receivable E-discounting Engine (NTREES), a web-based platform established in December 2009 for e-discounting of receivables of MSMEs. After seeking comments on the draft TReDS guidelines in July 2014, the RBI, in December 2014 announced the final guidelines and said the TReDS would be an authorised payment system subject to the RBI’s oversight under the Payment & Settlement Systems Act, 2007.

Noting that the TReDS will give MSMEs greater access to finance and put greater discipline on corporates to pay their dues on time, the RBI in November 2015 granted in-principle nod to three applicants, NSE Strategic Investment Corp-SIDBI, Axis Bank and Mynd Solutions to establish and run TReDS. The other applicants were Trade Receivables Exchange (Group of Banking Professionals)-Mumbai, DICIC Bank of India-Kolkata, NSDL Database Management Ltd-Mumbai and Trade Receivables Exchange-Mumbai. Since the TReDS will not be allowed to assume any credit risk, its minimum paid up equity capital shall be 25 crore, the RBI had said.

According to Mr. Mundra, “It would be important that the use of TReDS is made mandatory for, to begin with, corporate and PSUs and later for the Government departments.” He had asked the industry chambers and the MSME Ministry to “proactively examine this aspect as success of the TReDS initiative can be a game changer for the sector.”

Stakeholders’ key role

Ajay Kumar Kapur, Deputy Managing Director, SIDBI and on the board of Receivables Exchange of India Ltd (or RXIL – the NSE Strategic Investment Corp-SIDBI joint venture), said while SIDBI and NSE are the promoters of RXIL, a major factor that can lead to its success is that its stakeholders include SBI, ICICI Bank and Yes Bank.

These banks accounted for a sizeable portion of the credit to the MSME sector, and therefore had a good understanding of MSMEs and their clients, he said. SBI Caps and ICICI Securities are reported to be among the other investors in RXIL. Mr. Kapur said RXIL has got the RBI approval and will start operations soon. Meanwhile, FISME, in its proposals for consideration for the Union Budget 2017-18, said TReDS can be purposeful only if legislative backing is extended to it, making it necessary that the invoices are uploaded mandatorily and status of deemed acceptance is granted to them to convert them into negotiable financial instruments.

“This will not only provide much needed liquidity to MSMEs but will also usher in financial discipline in corporates and PSUs which is equally important for the country’s financial system,” FISME said.